Forex losses and enlightenment

As the National Australia Bank ponders what will happen when the
PricewaterhouseCoopers report into the $360 million foreign exchange
losses is revealed, maybe some of the senior managers could ponder the
personal website of rogue trader David Bullen:

NAB FX Options

An anonymous ex trader writes:

Don’t be smoke screened I am writing (anonymously) in regard to the NAB
FX fiasco. I am a retired FX options specialist and would like to share
some insights into the FX options world and the NAB “traders”. 
For the NAB management some insights into good practice for running and
FX derivatives business follow, free of charge.

Traders are given individual limits and depending upon the expertise of
the bank traders and risk management a detailed table and list of
limits is produced, usually by currency grouping. These limits mainly
relate to absolute $ loss expected within a certain level of

FX options books are usually loss limited on the basis of FX price
risk, volatility price risk, interest rate risk, discontinuous risk and
convexity risk. It is not a simple process and the traders earn their
money juggling a complex mix of limits creating new pricing tools,
distribution systems and creating new hedging and proprietary trading
products. They make markets in complex and often extremely leveraged
products. They earn their big salaries, do not doubt that. Even if some
are complete twats.

Please note it is common to be slightly over limits, but that plans are
in place for either new limits or position reduction. Some NAB boys
with 150million plus were a long haul flight over theirs. We’ll get
some insight why below.

Note that most of the options traders globally seem to manage. If you
cannot not then systems are usually in place to record the excess,
trade action plan on positioning taken and the offending
position/trader is usually within limit in 2-3 days.

MIS is crucial to informed decisions about position adjustment this
technology varies widely between banks and is usually built in house by
quantitative experts. Most institutions are being brought up the market
standard by local authorities. It is common practice for excesses above
limit to be recorded, signed off by more than one person, and a report
given to a team of senior managers.

At my bank any excesses had to be explained to the director of the
board representing financial markets, not something you want to do
everyday. It would make interesting reading if they did in fact keep
records which they should have and their internal reporting line. Then
again, hick bank in Melbourne? Maybe not. Most traders work in real
financial centres with quality support staff. Australian Tax rates are
to blame for the lack of local talent.

If excesses above limits were common as David states and I don’t
disagree having witnessed their trading style and deals, then why
weren’t trading limits increased?  It is the manager’s job to
ensure losses like the scenario that occurred should not happen. It is
possible a smart option manager bullshitted his risk management into
believing positions were not that large, as not many banks around give
you a loss limits of 150 million.

Your business is trying to make 10-100 million a year depending upon
the size of the bank, no one would sign a risk reward like that. Not
unless they were gunning for a billion dollar year. Good practice
involves stressing portfolios to see how bad it could be and evaluating
a dollar value for that outcome. This process was subverted due to
either bad risk management, devious activities by the traders or the
senior managers shutting up cause they may have got it right once and
everyone got a big fat cheque.  Thanks NAB shareholders!

Note the losses could have been worse if the position had become more
public earlier. How the NAB super dealers have fallen.  Regardless
of who gets blamed the intent was there. The people trading the
positions had to back up what they were doing everyday. The specialist
knowledge they enjoy means they were in a position to know exactly what
the fuck they were up to, even if the management were doing steaks and
Grange in Daniels. Like a black belt fighting with an amateur. Shoulda
known better boys.

I can here the drivel now down the cardies. “No one will know, it can’t
go wrong!”… I quote from the great Homer “ Doh!”. Mums and dads these
traders stole a little of your
retirement due to their arrogance, send them a Christmas card. Roll the
dice too often and that what’s happens.

The head of desk should make sure all individual traders are within
their personal limits and ensure the aggregate desk position is within
the overall risk limits for their business. The head of desk must
notify their risk management team of any breakages of limits and what
they intend to do about bringing this breakage back under the allowable
limit. If breaches occurred at NAB everybody knew about it, if they say
they didn’t then they are clearly lying.

Risk management are meant to ‘independently’ assesses the banks
positions and qualifies the adherence to the limit structure. Any
breaches are treated as a serious offence “usually” but seems not with
the NAB group. The positioning would have been very obvious and one
must look at the breakdown of the risk limit process or any devious
attempt to subvert the intentions of the limit system.

I had the ‘displeasure’ of meeting with the NAB ‘Dream Team’ when they
were at CBA. A formal meeting where their bigger than thou attitude
oozed from their condescending tones and one sat with his hand on his
unit inside his trousers slouched the whole time. Must be small! Any
one got a baseball bat?

The whole market was aware of the fiasco at NAB the rumours of their
type of deal, massive size of deals was enough of a flag. Style shift
to exotics in non-core AUD products was another, but last being the
deep in the money options via the broker market screamed dodgy. First
guess in every ones mind…NAB at it again. Seems the management at NAB
deaf and dumb? Anyone got a stick?

For the record, ‘Reval Trading’ or ‘TM Trading’ is a trade that
involves buying or selling positions based on the revaluation affect of
completing the trade when booked into in house dealing systems. Thus
showing profits for a position. This position is therefore misvalued,
as it is not held at market price rather at theoretical price.

Usually the profit is offset by a profit provision taken by your risk
management team until that position either expires, disappears or is
closed. Shit traders find this an attractive choice on losing days to
bring back the p/l and deal with the problem another day. Over time you
build a book or portfolio full of lottery tickets that other people own
and one day they win, and you gotta have the money to pay. It’s “pussy
trading” with no respect for shareholders capital at all. At most banks
this type of trading gets you fired immediately if suspected.

The NAB traders were talented, but often tried to be bigger than the
market. They’d look to control the FX options market and attitude took
over sense as they overtraded a position breaking limits and then being
forced to cut the position for a full spread in the market, just stupid
machismo stuff.

I personally mentioned to a NAB exec after the hiring of the “team’
from CBA that they could be a liability and that he should ask his risk
management team to check into their methods of valuation and practices.
No one seems to care about what happened to the CBA FX options profit
figures after the group was ‘poached’ to NAB. Rumour has it the cost to
fully value the misvalued positions left behind wasn’t small potatoes!

Options traded in the wholesale market generally involve out of the money options delta 0-50%. In
October 2003 a series of deep in the money options were going through
100% delta, VERY unusual indeed. There is no need to do this deal it is
a useless transaction it is in affect a forward outright deal, for
example a 0.5000 AUD call when spot is around 0.7900. There’s not
much optionality in that no matter what maturity. These deep in the
money options are generally used to wash profit and loss across
accounting periods depending upon the accounting application within
each bank. Most banks have a “no deals >65 delta” policy to avoid
being involved with deliberate p/l or cash flow manipulation. Did Mr.
Leeson hold classes in Singapore?

I agree with David that there are only a few who could have gotten the
bank out of the positions they were in at minimal cost, but also note
there are very few that could have been stupid enough to put the bank
in that much shit either.

If NAB tries to cover this up, it is a joke. Let the smokescreen begin.

PS – Snap out of it Dave!

Peter Fray

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